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| IPO Sentiment Index |
Empirical studies show that IPO markets are highly cyclical: hot issue phases are followed by periods with modest IPO activity. There are two main strands of theory explaining the decision of a company to go public.
While life cycle theories argue for an optimal point of time in the company life cycle to go public, market-timing theories stress the importance of capital market conditions for the timing of IPOs.
If market timing is important, the IPO climate is an important parameter for the success of an IPO that should be monitored continuously. The IPO sentiment index is such an innovative instrument to predict the climate for IPOs in Germany.
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It was introduced by the German stock exchange (the Deutsche Börse Group) in January 2006 and is calculated quarterly by the Center for Entrepreneurial and Financial Studies (CEFS) at Technische Universität München.
In comparison to other IPO climate indices, which are mainly based on a survey of market participants to observe their expert judgment, it additionally reflects the observed underpricing of the past.
Since empirical studies find a correlation between the level of underpricing and subsequent IPO activity (Lowry and Schwert, 2002), there is a good reason to include the observed underpricing in the prediction of IPO activity.
In its calculation, the IPO sentiment index (ISI) is calculated by multiplying the underpricing sentiment (USI) with the IPO climate (for further details in the calculation of the IPO sentiment index cf. Kaserer, 2006):
ISI = (USI x IPO climate) / 100
The USI considers the historical observed underpricing (the underpricing sentiment) in the last eight quarters. Based on prospect theory (Kahneman and Tversky, 1979), investors assess realized losses much stronger than realized profits. Therefore, negative underpricing is weighted one and a half of positive underpricing.
The second component, the IPO climate is based on a survey of market participants (banks, institutional investors, and venture capital/private equity firms) consisting of five questions (about the attractiveness of the current IPO market, current valuation level, and future IPO activity).
In its first year, the IPO sentiment index showed a good prediction capacity for future IPO activity in Germany. The historical development is regularly published on the webpage of the Deutsche Börse Group.
